SOFIA (Reuters) – Tax cuts and improved government controls have shrunk Bulgaria’s «gray economy» by about one-third in the past five years, but its share of the EU state’s economy remains large, a report showed yesterday. The independent Center for the Study of Democracy (CSD) estimated that unofficial economic activity in the Balkan country accounts for between 25 and 35 percent of the economy. «The heart of the gray economy lies in companies linked with political parties,» the report said. It said the politically sheltered companies were using the huge funds accumulated though illegitimate deals to expand their influence and control over large parts of the emerging economy. The CSD said administrative changes would have little effect on illegal businesses unless Sofia moves to sever links between crime groups and politicians and imposes strict rule of law. Bulgaria, which joined the European Union in January 2007, faces tough sanctions from Brussels over its failure to curb government and judicial corruption and tackle organized crime. The EU executive has already frozen some aid due to graft investigations and may also strip Bulgaria of some of the 11 billion euros in EU funds it is due to receive until 2013. The CSD, Bulgaria’s most respected anti-graft organization, said businesses sheltered by central or local administrations operated via webs of legitimate front companies. They work mainly in sectors where excise duties are charged, such as the production and trade of alcohol, cigarettes and fuels, and in the healthcare and energy sectors. The report said informal activity was above 50 percent in the construction and real estate sectors, which have boomed in the past few years. The poorest EU nation loses over 1 billion euros a year to graft and organized crime, surveys show. Diplomats and observers say the root of the problem lies in links between politicians and magistrates and criminal groups, some of which sprang from the former Soviet secret services.